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Tuesday, August 2, 2011

Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings for the U.S. while warning that the ratings could be downgraded if lawmakers fail to enact debt reduction measures and the economy weakens.

The rating outlook is now negative, Moody’s said in a statement yesterday after President Barack Obama signed into law a plan to lift the nation’s borrowing limit and cut spending.

The debt-limit compromise “is a positive step toward reducing the future path of the deficit and the debt levels,” Steven Hess, senior credit officer at Moody’s in New York, said in a telephone interview yesterday. “We do think more needs to be done to ensure a reduction in the debt to GDP ratio, for example, going forward.”

A ratings cut would raise the specter that the wrangling between Obama and Republican lawmakers over spending cuts and taxes will harm American prestige and the global financial system. JPMorgan Chase & Co. estimated that a downgrade would raise the nation’s borrowing costs by $100 billion a year. It could also hurt the rest of the U.S. economy by increasing the cost of mortgages, auto loans and other types of lending tied to the interest rates paid on Treasuries.

“A downgrade is a sign that Congress is failing to address a real fiscal issue,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in an interview before the announcements.

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‘Tough Choices’

A decision on the rating may be made within two years, or “considerably sooner,” according to Moody’s Hess. For Fitch, while the rating may be cut in the medium term, its risks in the near-term “are not high,” David Riley said in an interview.

Fitch expects to complete the ratings review by the end of August. The U.S. must confront “tough choices on tax and spending against a weak economic backdrop if the budget deficit and government debt is to be cut,” Fitch said in a statement.

“Although the agreement is a good first step in adjusting the fiscal challenges that the U.S. faces, it is just a first step,” Riley, Fitch’s London-based head of sovereign ratings, said in a telephone interview yesterday. “Does it mean that the AAA rating is completely secure of the medium term? No.”

The ratio of general government debt, including state and local governments, to gross domestic product is projected to climb to 100 percent in 2012, the most of any country with an AAA ranking, Fitch said in April.

Standard & Poor’s put the U.S. government on notice on April 18 that it risks losing its AAA rating unless lawmakers agree on a plan by 2013 to reduce budget deficits and the national debt. S&P indicated last week that anything less than $4 trillion in cuts would jeopardize the U.S.’s AAA rating.

Debt-Limit Compromise

An increase in Treasury yields of 50 basis points would reduce U.S. economic growth by about 0.4 percentage points, JPMorgan said in a report, citing Federal Reserve research and data.

Obama signed the debt-limit compromise on the day the Treasury had warned the nation’s borrowing authority would expire, ending a months-long debate that reinforced partisan divisions over federal spending.

The Senate voted 74-26 for the measure, which raises the nation’s debt ceiling until 2013 and threatens automatic spending cuts to enforce $2.4 trillion in spending reductions over the next 10 years. The House passed the plan Aug. 1.

“While the combination of the congressional committee process and automatic triggers provides a mechanism to induce fiscal discipline, this framework is untested,” Moody’s said in the statement. Moody’s said its baseline scenario assumes that fiscal discipline is maintained in 2012.

Debt-to-GDP

“Further measures will likely be required to ensure that the long-run fiscal trajectory remains compatible with a Aaa rating,” Moody’s said. The credit rater expects a stabilization of the federal government’s debt-to-gross domestic product ratio not too far above its projected 2012 level of 73 percent by the middle of the decade, followed by a decline.

Recent downward revisions of economic growth rates and the very low growth rate recorded in the first half of 2011 call into question the strength of potential growth in the next year or two, Moody’s said. Moody’s, which has rated the U.S. Aaa since 1917, put the U.S. under review for a downgrade on July 13 for the first time since 1996.

Still, U.S. bonds and the dollar have signaled increased demand for the assets of the world’s largest economy even as the prospects of losing the AAA rating rose as the debt talks extended to the deadline when the Treasury said it would exhaust its ability to borrow.

Yields Decline

Treasury yields average about 0.70 percentage point less than the rest of the world’s sovereign debt markets, Bank of America Merrill Lynch indexes show. The difference has expanded from 0.15 percentage point in January.

Investors from China to the U.K. are lending money to the U.S. government for a decade at the lowest rates of the year. For many of them, there are few alternatives outside the U.S., no matter what its credit rating.

Treasury 10-year yields fell to as low as 2.60 percent yesterday in New York, the least since November. The dollar represents 60.7 percent of the world’s currency reserves, compared with the 26.6 percent for the euro, which has the next biggest portion, according to the International Monetary Fund in Washington.

“Regardless of the rating, Treasuries are going to be seen as the safe haven,” said Matthew Freund, a senior vice president at USAA Investment Management Co. in San Antonio, where he helps oversee about $50 billion in mutual fund assets. “The U.S. remains one of the strongest, most dynamic economies in the world.”

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